Understanding a company’s financial statements is an asset for any investor. It allows them to seize opportunities and avoid certain pitfalls. Here’s how to analyze them.
What are financial statements?
Financial statements are documents that a company must present at its annual meeting. Usually prepared by a certified public accountant (CPA) with assistance from management, they show different facets of a company’s financial health and must be approved by the board of directors. Financial statements help administrators and directors make the right decisions.
Here are the three main types of financial statements:
- Balance sheet or statement of financial position: This presents the company’s assets and debts as well as capital as of the exact date of the end of the fiscal year.
- Income statement: This indicates income, expenses and profits during the fiscal year.
- Cash flow or statement of changes in financial position: This provides information about the company’s activities, financing from various lenders and investments. It reports the company’s cash flow.
As an investor, you can unearth valuable information from these statements. Here is some information you should examine closely.
1. Earnings per share
This ratio indicates the amount of net earnings compared to the number of company shares. In other words, it is the amount you would receive for each share if the company returned all its profits.
This data is generally already calculated in public companies’ financial statements. By comparing the information with that of previous years, you can evaluate the company’s growth rate and figure out the company’s position compared to its competitors.
2. Book value per share
The book value per share is an interesting ratio for a future investor. It can indicate whether the price of a company share is undervalued or overvalued. To calculate it, subtract the value of preferred shares from the shareholders’ equity. Then, divide the result by the number of shares in circulation.
If the share price is lower than its book value, the security may be undervalued. It would therefore have good growth prospects, which would reflect a potentially interesting purchase.
3. Accounts receivable collection
In financial statements, revenue should grow faster than accounts receivable. To evaluate this ratio, you have to divide the accounts receivable by the daily revenue.
A high ratio is reason to be cautious—a company could eventually experience problems getting paid.
The relative liquidity ratio indicates whether the company can meet its immediate obligations without selling inventory and without including its prepaid expenses. To calculate it, first add up cash, accounts receivable and short-term investments. Then you need to divide the result by current liabilities.
The result will indicate whether or not the company has difficulties meeting its commitments.
For more information, read the full article on National Bank website.